Taxation and Customs Union

Updated on June 28, 2022

 

What is a right to deduct?

It is a taxable person’s entitlement to claim the VAT paid for goods and services that he or she has purchased from the tax authorities.

In the ordinary VAT return filed to the tax authorities, the deductible amount is subtracted from the due VAT.

Which VAT can be deducted?

It is possible to deduct the VAT owed or paid for the following transactions:

Supplying products or services domestically is considered as a transaction.
Transactions and acquisitions within the European Union are considered as such.
Goods importation.

Which activities give rise to deduct?

In order to deduct VAT, only products and services utilized in the following activities are eligible:

Certain exempt and non-taxable transactions; international transactions that would otherwise be eligible for VAT deductions; and transactions that are carried out outside the country if they would otherwise be eligible for VAT deductions in their home country.
New modes of transportation supplied across national borders; some financial transactions with non-EU consumers exempted.

Can VAT be deducted fully or partly?

It is possible to deduct the entire cost of the VAT incurred throughout the course of engaging in activities that give rise to the VAT deduction.

It is not possible to deduct VAT paid on goods and services that do not qualify for such a deduction.

It is possible to claim a proportional deduction in instances in which direct apportionment of expenditure either to an untaxed supply or an untaxed supply with a right of deduction cannot be made.

Certain kinds of expenses aren’t eligible for tax deductions.

When does the right to deduct arise?

When a tax is deductible, the entitlement to deduct is established (Article 167 VAT Directive).

Chargeable events and chargeability explain when VAT is applicable. As a general rule, VAT becomes taxable when:

for intra-EU acquisitions, upon issuance of the invoice; for imports of goods, upon importation of the items.
Cash-accounting schemes are subject to a special rule [link].

Why does it matter when the right arises?

The duration of time during which the firm has the right to deduct input VAT is determined by the occurrence of the right to deduct. Often, this occurs before the VAT has been paid.

Domestic supplies of goods and services and transactions treated as such

Type of transaction on which VAT is deducted Conditions to deduct

 

 

Consumption within the country
Regulations on Value Added Tax (VAT)
The domestic purchase is subject to VAT, which must be paid.

VAT is a problem in all EU countries.

The actions that give rise to a tax deduction are carried out with the aid of purchased products and services.

Transactions that are classified as “supply” transactions
Article 168(b) of the EU VAT Directive
When an EU country’s transactions fall within Article 18(a) and 27 VAT Directive, they are subject to VAT.

Supplying one’s own products and services to one’s own firm; [link]
EU countries face the same tax burden;

Activities that lead to deductions need the usage of goods and services.

Intra-EU acquisition of goods and transactions treated as such

Type of transaction on which VAT is deducted Conditions to deduct
Intra-EU acquisition of goods
Article 168(c) VAT Directive
VAT is due on intra-EU acquisition of goods;

VAT arises in the EU country of the acquisition of goods;

Acquired goods are used for the activities giving rise to deduction.

Transactions treated as EU- acquisitions
Article 168(d) VAT Directive
VAT is due on a deemed intra-EU acquisition of goods:

  • Article 21 transactions [link]
  • Article 22 transactions[link];

VAT arises in the EU country of the acquisition of goods;

Acquired goods are used for the activities giving rise to deduction.

Importation of goods

Type of transaction on which VAT is deducted Conditions to deduct
Importation of goods
Article 168(e) VAT Directive
VAT is due or paid on importation of goods;

VAT arises in the EU country of importation of goods;

Imported goods are used for the activities giving rise to deduction.

Taxed transactions of the taxable person

Type of transaction giving rise to deduct Conditions for deduction to arise
Taxed transactions of the taxable person
Article 168 VAT Directive
Goods and services are used for the taxed transactions of the taxable person in the same EU country.

Certain transactions carried out abroad

Type of transaction giving rise to deduct Conditions for deduction to arise
Certain transactions carried out abroad
Article 169(a) VAT Directive
Transactions are related with any economic activity of the taxable person:

 

Transactions exempt with the right to deduct

Type of transaction giving rise to deduct Conditions for deduction to arise

Certain transactions are exempt, such as:

Goods supplied within the EU;

Intra-EU shipments of products to and from the Azores and Madeira, as well as inter-EU transit of goods;

Services related to the importation of products, the value of which is included in the taxable amount;

Goods exportation;

International transportation services, comprising transportation between the Azores and Madeira islands, as well as between the islands and the mainland;

Certain supply to international bodies, for example, are considered exports.

The gold supply to central banks;

Supplies of commodities to or within customs, tax, free zones, or free warehouses, as well as related services

Provision of goods for retail sale in tax-free stores, sale on board, and so on

Goods supplied under temporary importation agreements or through the EU’s internal transit mechanism

Certain exempt financial transactions

Type of transaction giving rise to deduct Conditions for deduction to arise

Certain transactions are exempt, such as:

transactions in insurance and reinsurance,

Negotiations and credit granting, as well as management of the credit by the person who granted it;

interactions with credit guarantees and the person who granted the credit’s administration of them;

excludes debt collection, transactions involving deposit and current accounts, as well as other negotiable instruments;

currency exchange deals;

Excluding management and safekeeping, as well as documents demonstrating title to commodities and rights in rem, transactions in shares, interests, and other securities

Article 132(1) VAT Directive points a) to f)

Only the VAT exempt transactions stated in Article 169(c) of the VAT Directive are eligible, and only if one of the following two conditions is met:

the customer is based outside of the European Union (EU) or

The transactions are directly related to items that will be shipped out of the country.

Deductions for cross-border supplies of new means of transport

Type of transaction on which VAT is deducted Conditions to deduct

Article 172 VAT Directive: Deductions for cross-border supplies of novel modes of transportation
Anyone who transports new vehicles to another EU country on a regular basis.

Only a small portion of the VAT paid can be deducted.
The right to deduct arises and can be used only when the new mode of transportation is provided.

Proportional deduction

When does proportional deduction apply?

Input deduction on a proportional basis When a taxable person (company) engages in both VAT-deductible (taxed supply) and non-deductible (untaxed supplies) activities, VAT is applied (most exempt supplies, for example).

The fundamental principle
Only a portion of a company’s VAT on products and services used for both VAT-deductible and non-deductible transactions can be deducted.

What method is used for attribution?
Article 173(2) of the VAT Directive specifies a number of ways that can be utilized, but each EU country must choose one.
There are three types of attribution methods: (1) sectoral attribution, (2) direct attribution, and (3) indirect attribution.

Method Description
Sectoral attribution EU country may:

authorise the business to determine a proportion for each sector of its business, if it already keeps separate books of account for each sector or
require the business to keep separate books of account for each sector of its business and to determine a proportion for each sector.

Direct attribution EU country may authorise or require the business to deduct or not to deduct on the basis of the actual use to which all or part of the goods or services is put in respect of a specific transaction.
Global attribution EU country may authorise or require the business to base the deduction on the use to which all goods and services are put in respect of all its transactions.

Countries in the EU are not obligated to choose one technique over the others.

Where the amount of non-deductible VAT is relatively tiny in comparison to the deductible amount under any of the three ways, EU countries may choose to equal it to nil and therefore enable full deduction.

How is the deductible proportion calculated?

The deductible percentage is determined as a percentage, with the following formula:

Both transactions that qualify for VAT deduction and those that don’t qualify for VAT deduction are included in the numerator and the denominator of the total VAT-exclusive annual turnover.
European Union member states have the option of including non-price-related subsidies in their denominators, or not.

Some figures must be omitted from the equation. In terms of revenue, these are some of the numbers:

Provisions for business use of capital goods; disposals of capital goods in countries where capital goods are not adjusted (see Deductions: capital goods adjustment); incidental transactions with immovable property and incidental financial transactions; and incidental exempt financial transactions listed in points (b) to (g) of Article 135(1) of VAT Directive.

How often is the deductible proportion calculated?

The deductible percentage is computed once a year, according to the regulations. There may be an initial usage of an estimated percentage of transactions from the previous year, and an adjustment is performed when the final percentage is known.

The business can use its own estimates to estimate the provisional proportion if there are no or insufficient transactions from the previous year on which to base it.

Countries that joined the European Union after 1 January 1979 may keep the regulations in effect at the time of their accession, whereas EU countries that had different rules in place at that date may keep those rules.

(Vat Directive under Article 175)

How precise must the deductible proportion be?

Percentages must be specified and rounded to the nearest whole number, with no decimal places in between.

Example

Business B Co has a total of EUR 70 000 in VAT-excluded sales that qualify for deduction and EUR 50 000 in sales that do not. Additional capital items of EUR 12,000* were sold.

60.33 percent of the total is deducted from the total.
This can be rounded up to a maximum of 59 percent.
Capital goods are not included in the deductible proportion in B Co’s nation.

Restrictions on deduction

When can the right to deduct be restricted?

The entitlement of a taxable person (company) to deduct the VAT incurred on goods and services purchased or acquired is restricted by just two global limits.
VAT cannot be deducted from non-business expenses.

Luxuries, amusements, and other forms of leisure time enjoyment are not included in the definition of “expenditure” as defined in Article 176 of the VAT Directive.
There will be a general restriction or block on the deductibility of VAT for certain specific types of expenditures, which has been agreed upon by all EU members.

Exclusions in existence on January 1, 1979, may be retained by EU countries until such time as they are no longer necessary (or as at their date of joining the EU, if later). VAT deductions on corporate entertainment are still denied in some EU nations, for example.

Expenditure on capital goods may be completely or partially excluded from the right to deduct, subject to consultation with the VAT Committee, for cyclical economic reasons.

Rather than reject depreciation deductions, EU nations may charge products the business manufactures or purchases within the EU or imports from third countries, but not more heavily than they tax the procurement of equivalent goods from other countries.

(Vat Directive, Article 177.).

Evidence and procedures for deduction

What evidence or procedures are needed for a deduction?

Taxpayers (businesses) can only claim deductions if they meet certain requirements. Depending on the specifics of the transaction, the proof or conditions needed to support the claim will vary.

The deduction is claimed for VAT on: Evidence/conditions required
Supply of goods and services Business must hold a valid VAT invoice.
Transactions treated as a supply of goods or services Rules are laid down by the individual EU country.
Intra-EU acquisitions of goods Business must hold a valid VAT invoice and provide the information required in its VAT return.

However, EU countries may choose to override this rule and allow businesses to make the deduction even where they do not hold a valid VAT invoice

Transactions treated as intra-EU acquisitions Rules are laid down by the individual EU country.
Imported goods Business must hold an import document naming it as the consignee or importer and stating the amount of VAT due or enabling that amount to be calculated.
Reverse-charge VAT Rules are laid down by the individual EU country.

(Articles 178 , 181 VAT Directive)

Regardless of the above, EU countries have the authority to allow businesses to make a deduction in cases where they have not been able to comply with the requirements above and/or with the method of making deductions. The EU country concerned will set its own detailed rules for this.

(Article 180 VAT Directive)

How and when deductions are made

The basic rule

When filing a VAT return for a given period, taxpayers (companies) must demonstrate that they have the right to deduct input VAT by:

deducting from the total amount of VAT owed by them in that period the input VAT for which a claim of deduction has arisen (Article 179 VAT Directive)

See VAT returns for information on how and when to file a return.

See chargeable events and chargeability for more information on when VAT is required.

With the exception of sporadic transactions, there is no restriction.
EU countries have the option of requiring that people who are regarded as taxable persons because they make occasional purchases of goods and services be taxed.

land or a building before occupying it, but not until they’ve made a sale can they claim their right to a deduction? (Article 179 VAT Directive)

See Chargeable event and chargeability for more information on when a supply is made.

Is it possible to deduct more VAT than is really owed?
For any period in which the amount of VAT that a business can deduct exceeds the amount of VAT it must pay, EU countries have two options:

excess might be refunded or carried over to the next period.
Even if the amount is negligible, they may refuse to refund or carry forward an excess.
VAT Directive (Article 183).

Adjustments of deductions

General rules

When can or must an adjustment be made?

It’s possible that after making a deduction (‘the original deduction’), the conditions behind the deduction change, making the deduction incorrect. One reason for this is that:

purchase that was supposed to be subject to VAT has been reversed
To compute the final amount deductible, the capital goods system is applied to a purchase in which a price reduction has been secured but payment has not yet been made in full or in part.

When must an adjustment be made?

When an initial deduction is higher or lower than the deduction to which the taxable person (company) is entitled, the original deduction must be adjusted accordingly (Article 184 VAT Directive).
For example, when purchases are canceled, price reductions are received or other parameters used to calculate the deduction are changed, this is a common occurrence
The only exceptions to this rule are unpaid transactions and the destruction, loss, or theft of acquired goods (subject to proper proof or confirmation).

The EU countries, on the other hand, may choose to demand an adjustment in the event that:

Any unpaid or stolen transactions remain unresolved (Article 185VAT Directive)

What is the procedure for adjustments?
Every EU country provides national rules for making adjustments (Article 186 VAT Directive).

Adjustments for capital goods

What are capital goods?

‘Capital goods’ is not defined under the VAT Directive; member states are responsible for coming up with their own definitions.

A fixed asset, by definition, is an item that may be used for a long period of time (at least five years), such as an immovable property or expensive computer equipment, and is not limited to one single company or non-business usage.

Articles 187-191VAT Directive contain the capital-goods adjustment regulations.

What about services?

EU countries have the option of treating services that share characteristics with capital commodities as capital goods.

When should input VAT on capital items be adjusted?
Any time throughout the adjustment period, the usage of the products for taxable (taxed/exempt) transactions changes, an adjustment must be made.

Consequently, adjustments for capital goods need not be made if the business exclusively conducts transactions that are taxed, exempt with the right of deduction, or non-taxed.

Proportional deductions made at any moment throughout the adjustment period will consequently be subject to this rule

How lengthy is the transition period?
A five-year adjustment period is standard, counting backwards from the year in which the products were purchased or created..

If the items are utilized for the first time, EU countries might begin counting this period from the date of purchase.

EU countries have the option of extending this time for immovable property by a maximum of 20 years.

Is it necessary to make the modification more frequently?
During the period of adjustment, an annual adjustment is made. Proportionate deductions in general are not affected by this rule, as long as the degree of entitlement for a deduction (determined in accordance with proportional deductions generally) remains unchanged.

Do you know how it’s done?”
A year’s worth of adjustments can be calculated using the following formula:
Difference in entitled percentage x (VAT on first acquisition/number of years in adjustment period)

Example
For the price of EUR 200 000, a business that conducts both taxed and exempt transactions buys a computer system for his factory. The purchasing price includes a tax of EUR 40 000. The period of adjustment is five years.

60 percent of taxed transactions are used in the first year. When it comes to yearly percentages, it’s 56% in Year 2, 66% in Year 3, 60% in Year 4, and 58% in Year 5.

The following are the deductions and adjustments:
40,000 x 60% = 24, 000 in the first year
Because of national tax authorities, the second year’s total is (40 000/5) * (60 – 56) = 320
(40 000/5) x (65%-60%) = 400 deductions in year 3
The fourth graders
There has been no change to the entitlement percentage (60%)
As a result of the national tax authorities, Year 5 (40 000/5) * (60 – 58 %) = 160.

Capital items can be sold or transferred during their adjustment period.
Only one adjustment period is required. Only one adjustment must be made if the transferee (new business owner) buys the items while the transfer period is still active. A taxable supply means that the company’s original deduction (first entitlement percentage) is 100%. The supply’s initial entitlement percentage is 0 if it is exempt from regulation.

Individual EU countries have a variety of options.
It is up to EU countries to decide how to implement the capital goods adjustment mechanism, including:

establish their own concept of capital goods
include any applicable state and local taxes in the recalculation.
take efforts to avoid the acquiring of an unwarranted advantage \smake administrative simplifications.
Is the scheme for adjusting capital goods required?
Yes, in most cases.
Under the following situations, an EU country may choose not to operate it:

Implementing the scheme has little effect on the economy in terms of practicality; it takes into account overall impact of VAT and the need for administrative simplification; and it consults the VAT Committee in advance.